Printing money and forcing interest rates to near zero, that’s how the Fed and other central banks papered over the Financial Crisis, duct-taped the bursting credit bubble back together, inflated new asset bubbles, and propped up TBTF banks. And in so doing, they accomplished a huge feat: a worldwide tsunami of hot money.
QE drove yield-seeking investors, whose livelihood was evaporating before their very eyes, to chase down yield wherever they could find it, no matter what the risks, and they found it in emerging markets and in junk. India, Indonesia, Thailand, Brazil, and other developing countries could suddenly borrow from the future at record low rates – much like developed countries – to goose growth. Companies, governments, and consumers ran up debts. Imports ballooned.
It had nefarious consequences. As the Fed was trying to devalue the dollar, other currencies rose. In September 2010, Brazilian Finance Minister Guido Mantega denounced the “international currency war” that the money-printers in Washington and elsewhere were waging against his and other emerging countries where the hot money had washed ashore. “This threatens us because it takes away our competitiveness,” he warned.
But in early May, when the Fed penciled “taper” on the calendar as something to consider, the hot money got antsy. That month, interest rates started to soar globally. Junk bonds got slammed, as did the debt of emerging markets, particularly of countries that had splurged on imports and had to fund large current-account deficits.
The selloff doused all sorts of hopes in India and has since contaminated Indonesia, Thailand, and other countries. As Dallas Fed President Richard Fisher explained so eloquently last Friday on Fox: “I think the market has come to realize there is no QE infinity.”
Since QE infinity turned into a pipedream in early May, the Indian rupee lost 20% of its value, hitting a historic low of 64.13 to the greenback early Tuesday, after a 2.3% swoon on Monday. The Indian stock market index Sensex has fallen over 11% since mid-July. Government debt, a hair above junk, got hammered, with the 10-year yield jumping 20 basis points on Tuesday to 9.43%, a Lehman-moment high. The stench of crisis was in the air, and investors who’d been holding their noses for years, finally smelled it and tried to yank their money out.
India, which is in dire need of foreign capital, is a sitting duck. It has to fund a large current-account deficit. It’s importing much of its energy, but the crashing rupee is turning that into a burden for the economy. Badly needed reforms haven’t happened, or only minimally so. A slew of issues, such as inadequate infrastructure and electricity supply, bedevil the country, but they’re not being dealt with. Instead, the government is ingeniously trying to tamp down on gold imports. And it limited the amount of money people and companies can send overseas. Outright capital controls would be next.
To assuage his nervous countrymen, Economic Affairs Secretary Arvind Mayaram, a senior official at the Finance Ministry, announced on Tuesday, “There is no intention of government of India to put any capital controls as such.”
To prop up the rupee, the Reserve Bank of India had been raising interest rates, but the higher borrowing costs hit the corporate sector, and investors lost their appetite for bonds. It tightened liquidity to make it harder to short the rupee. Nothing worked. So on Tuesday, to save the day, it dumped dollars hand over fist. And to prop up the collapsing bond market, it announced that it would buy 80 billion rupees ($1.3 billion) worth of government bonds with long maturities on August 23. It would decide later how much more it would have to buy.
Alas, buying bonds to prop up the bond market and force down long-term interest rates contradicted its efforts to prop up the rupee by raising interest rates. QE with all its messes has arrived in India to stave off the crisis caused by the consequences of QE, or rather the end of QE, in the US. But it did stop the rupee’s slide on Tuesday, at least temporarily.
Similar selloffs are circulating around the developing world as the hot money is pulling out. In Indonesia, the rupiah dropped to a four-year low. The Jakarta Stock Exchange Composite index is down 20.5% since May 20. The government is in full prop-up mode. Its state-owned pension fund PT Jamsostek announced that it would buy equities to halt the four-day 11% slide. That deus ex machina caused the stock market to recover a little after having been down 5.8% intraday, to close down only 3.2%.
What QE giveth, the end of QE taketh away. And this is just the beginning. The Fed hasn’t even announced the end of QE; it is merely palavering about it. And it has affirmed that its zero-interest-rate policy would remain in place, possibly for years to come. The Bank of Japan is in all-out QE mode. Other central banks haven’t given up on it either – because just idle banter of ending QE has these kinds of consequences around the world.
The emerging markets were among the first destinations for the hot money. It’s logical that they would be among the first places the hot money is trying to get out of while it still can. As the end of “QE infinity” approaches, and if the Fed actually stops printing money for the first time in five years of drunken partying, the movie now playing in the emerging markets will likely start playing at theaters closer to home.